Securities Based Lending The Smarter Alternative to a Loan or Mortgage 01/15/2010
Contents Product General Description Parameters Criteria what securities can and cannot be used Loan Process Security Info Term Sheet and Application Loan Agreement and Delivery Instructions Receipt of Securities and Strike Price Closing Statement and Funding Servicing Interest Statements Options if Borrower Defaults Options at Loan Maturity Frequently asked questions General Questions Tax Questions Collateral Questions
Product General Product Description The lender is a private non-purpose lender, that specializes in non- recourse loans. This is a securities loan for which the collateral is the securities that the borrower currently owns. Product Parameters a) The loan proceeds can be used for anything except for the purchase of securities or carry securities in a margin account. b) Very Low Rates ranging from 2.5% to 4.5% c) The borrower retains beneficial interest. The borrower retains all upside market appreciation and receives any dividends or interest to which the securities are entitled. This credit would be applied to the borrower s next quarterly interest invoice. Any overage will be refunded to the borrower. d) Eligible securities include publicly traded stocks, bonds, tradable mutual funds, unit investment and real estate investment trusts as well as Foreign positions traded on international exchanges. e) Ineligible securities include privately held stock, securities held in retirement accounts (401Ks or IRAs), annuities and stock held by affiliates (shareholders who are directors of the company). f) Loan to securities values (LTV) range from 35% to 80%. The more liquid and actively traded securities receive the higher LTVs.
Product Product Parameters continued g) Non-recourse with downside protection. 1) Non-recourse means that the only asset the lender can seize if the loan goes into default are the securities that were originally pledged as collateral for the loan. The lender cannot go after any other personal or real estate assets of the borrower. 2) Downside protection. All loans have a default feature. The default trigger for these loans is 80% of the loan value. For example, assume the stock had a full market value of $ 100,000.00 when the loan was made. Also, assume the loan term established a 70% LTV, so the loan was 70% of the full market value or $70,000.00 if the value of the stock falls below 80% of the loan amount, $56,000.00 then there is a default and the borrower has two options. a) The borrower can walk away, keeping the loan proceeds of $70,000.00 At this point, the lender would keep the pledged securities or b) The borrower can deposit funds or securities to bring the value back up to 80% of the loan amount. This, in effect, buys down the default floor to 80% of the loan amount minus the funds required to be deposited. h) Rates are fixed during the term of the loan. i) Interest only payments. There are no scheduled principal payments or prepayments of the loan balance. j) The interest is paid on a quarterly basis.
CRITERIA Securities that qualify as collateral are: Publicly and Actively traded stocks, mutual funds, bonds and treasury notes that are not restricted in any manner. Most foreign securities are acceptable. What cannot be used: 401(k)'s, IRA's or any restricted retirement fund Money Market Accounts* CD's* Annuities Gold or silver mines Commodities CMO's SBLC's Bank Guarantees or Warranties Private notes or private bonds Bonds that are coming due within 3 years Bearer Bonds *can be converted to cash then securities may be purchased and used as collateral. - Minimum loan amount is $100,000.00 - Minimum loan term is 3 years - Minimum average trading activity on stocks must be $50,000 per day. (Average volume x current share price.) - Borrower must have proof of ownership of the securities. - We do not ask for credit history, income, employment or the intended use of the funds.
Loan Process a) Borrower supplies copies of most recent stock portfolio statements. 1. Request loan amount 2. Request loan term 3, 5, 7 or 10 years 3. Specify what securities and number of shares will be pledged and transferred b) Lender will review and calculate the LTV and rate for the requested loan term. A term sheet and a two page application will be sent directly to borrower from the lender. The term sheet outlines the terms of the loan: the LTV, rate, the length of loan, applicable securities and number of shares. c) The borrower signs the term sheet, fills out the application and returns both. Within 24 hours the lender will return the loan agreement and closing instructions to the borrower. The loan agreement is signed by the borrower and returned to the lender the delivery instructions are completed by the borrower and sent to the brokerage firm where the securities are currently held. d) After the securities are received at the lender s custodial account, a current market evaluation is determined. This is needed to determine the exact loan amount which will be disbursed. The closing price of the security is taken for three days, starting with the day the securities are received. An average is taken of the three closing prices. This is known as the strike price. The strike price is multiplied by the number of pledged shares and then multiplied by the pre-determined LTV. This is the loan amount. e) A closing statement outlining the strike price, LTV, rate, amount of loan proceeds and other terms of the loan is sent to the borrower on the third day of receiving the securities. The loan proceeds are then wired to the borrower s account per the arrangement set forth in the term sheet.
Servicing Interest Statements: The loan is interest only, no principal payments or prepayments. The interest is paid on a quarterly basis. The borrower will receive an invoice via FedEx approximately one month prior to the due date of the invoice. Payment is expected on the due date. The borrower s payment is made directly to the lender and can be made by check or wire transfer, Options if Borrower Defaults: This is a non-recourse loan. So, if the borrower defaults the borrower may walk away, keeping the loan amount. The lender keeps the pledged assets. The lender has no recourse against the borrower s personal or real assets. Options at Loan Maturity: a) The borrower pays off the loan and the exact number of pledged shares is returned to the borrower. b) The loan may be renewed for a period of time, usually for the same period as the original term but may be different terms given current market conditions. c) The loan may be refinanced if the securities have appreciated in value. New loan documents will be completed with a new loan amount. Terms may be different given current market conditions.
FREQUENTLY ASKED QUESTIONS General Questions: Q: Is there a restriction on the use of the loan proceeds? A: A borrower may essentially do anything with the loan proceeds except buy or carry marginable securities with the proceeds. Q: How are the rate and loan to value determined? A: The rate and loan to value are driven by several factors. The biggest drivers are the daily trading volume, share price, volatility and dividend yield of the pledged securities. The term of the loan will also affect the rate. A fortune 500 company s stock will be analyzed more favorably than a dollar stock that is traded publically but has very little trading volume. Q: "Am I personally liable for this loan or can the company comes after me on this loan if I do not make the payments?" A: No, this is a "non-recourse" loan; the lender cannot come after you personally. There is no personal liability associated with this type of loan. The only security for the loan is the stock and the only recourse the lender has is against the stock. The borrower has no personal liability exposure. Q: Is this loan reported to the credit bureaus or reporting services? A: No, the loan is not reported to the credit bureaus and there is no public record of this loan. Even if the borrower elects to walk away from the loan and default because, for example, he or she has more money than the stock is worth, it is not reported. Q: What happens if I fail to make my required payments on the loan? A: If the borrower does not make the interest payments when due or fails to repay the principal when due, the lenders only recourse is against the stock. The loan will be terminated and cancelled. The borrower gets to keep the money received for the stock and the lender gets to keep all interest in the stock. The default or termination is not reported to any credit bureaus.
Tax Questions: Q: Is the transfer of the stock for the loan a sale? Are there taxes associated with the transfer of the stock for the loan? A: No, this is not a taxable transfer. This type of transaction is specifically addressed in Internal Revenue Code 1058 which specifically states that taxpayers who enter into a qualifying stock lending agreement receive non-recognition treatment with respect to any gain or loss at the time of the transfer of the securities. This section provides an exception to the general income recognition principles of Section 1001 of the Internal Revenue Code. This is a common transaction in the financial markets. Q: Is the interest I pay deductible like a mortgage? A: The answer to this question is entirely dependent on what the borrower does with the loan and how they structure the loan. The borrower will have to consult with their own tax advisor for the final answer. However, there are generally recognized rules which we can share. I. Interest on ordinary personal debt, like a credit card, is not tax deductible. No deduction is allowed for personal interest. II. In regard to mortgage interest, this is only deductible if the debt giving rise to the interest is secured by a mortgage on the taxpayer's qualified residence. Since the loan is a non-recourse loan and not secured by a mortgage, the interest does not qualify for the mortgage deduction. III. A borrower may be able to take a tax deduction for interest paid on a loan to fund business or investment activities; to the extent investment income exceeds investment interest. So, under the Securities Lending Agreement, where the borrower invests the money and pays interest to the lender, the borrower's interest payments could be tax deductible as investment interest. Likewise, interest payments may be tax deductible if the loan proceeds are used for business purposes. Business or Investment activities could be considered as: a) Interest paid or accrued on indebtedness properly allocable to a trade or business.
Tax Questions: cont b) Any investment interest, which generally includes interest paid or accrued on indebtedness properly allocable to property held for investment; and c) Interest taken into account in computing income or loss from a passive investment activity. The borrower should consult with his or her tax advisor prior to entering into this loan if this is a concern. There are simply too many individual variables and circumstances for us to give any kind of tax advice. This is not tax advice, but only a general discussion of the issues. Q: What happens if I default on the loan? A: On a non-recourse loan the borrower has no personal liability. The stock is simply forfeited. Q: Is there any tax consequence should I default on the loan? A: There are general rules we can share regarding tax treatment of a default. The amount realized is the difference between the loan amount and the cost basis in the stock. Example: 1) Assume the market value of the stock was $100,000.00 and the loan amount was $50,000.00 2) Assume the borrower had a cost basis in the stock of $10,000.00 3) The amount subject to tax is the difference between the loan amount $50,000.00 less the cost basis $10,000.00 The amount subject to tax is $40,000.00 This will typically be treated as a capital gain. Please consult with your accountant or tax adviser for a final answer.
Collateral Questions Q: "Who owns my stock during the loan?" or "Who has title to my stock during the loan?" A: The stock is transferred to the holding company which has full title, but the borrower retains all beneficial interests in the securities. The borrower will receive any dividends, interest or any other benefits that flow from the stock during the term of the loan. Q: "If the stock has a dividend during the loan will I receive it? A: The borrower receives a credit against the interest payment of all amounts equal to dividends, interest or other distributions on the stock during the term of the loan. Any excess income derived from the security is returned to the borrower. Q: What if the value of the stock falls significantly? Or What does this default provision in the loan mean? A: If the value of stock falls below the agreed minimum value in the contract, then there is an event of default. The minimum value is 80% of the loan amount. For example: assume the stock had a full market value of $10 per share when the loan was made. Also, assume the loan terms established a 70% LTV, so the loan was for 70% of the full market value or $7 per share. If the value of the stock falls below 80% of the loan amount, here $7, then there is a default which can be cured by the borrower. In this example, the share price would have to go below $7 x 80%, or $5.60 per share. For a default to occur, the share price in the example must fall more than 44%. While the interest rate and interest payment remain constant, due to the volatility of the collateral, the contract may require the borrower to contribute additional cash or shares to keep the loan viable. The decision to tender additional cash or securities is solely in the borrower's hands. The borrower could choose not to risk more capital and terminate the loan or the borrower could choose to keep the loan in good standing by curing the default caused by the loss in value of the collateral. The additional cash or shares tendered to cure the default do not become part of the collateral for the loan and are not subject to repayment or refund at any time. At origination, the borrower and the lender agreed to a minimum fair market value for the collateral of the loan. Those funds "buy-down" the price of the security to set a new floor for the stock and thus maintain the minimum value ratio between the amount of money loaned and the minimum value of the security for which the lender is willing to be at risk.